This morning the UK Government announced a suite of measures intended to improve liquidity in the financial system and strengthen the capital base of certain financial institutions, with a view to these institutions, once recapitalised, being able to tap the international capital markets once again for their capital and funding requirements.
Based on details available so far, this seems a clever initiative to support UK banks in raising funds in the open markets rather than by nationalisation. Avoiding nationalisation should make the arrangements easier to unwind when normal market conditions return and avoid systemic triggering of rights in financial instruments arising on nationalisation.
The three limbs of the proposal announced today are in summary as follows:
The Bank of England will extend its special liquidity scheme for banks
Since last December, banks which have not been able to raise adequate funds by borrowing from each other (as they normally would) have had funds made available to them by the Bank of England against collateral over prescribed eligible assets of the banks. The announcement today notes that the Bank of England will announce further changes to this Special Liquidity Scheme next week, and that at least £200 billion will be made available for the scheme.
The Government will make available £50 billion (or potentially more), if required, to help banks recapitalise
This is the most widely reported aspect of the announcement. The lack of confidence in banks recently has been fuelled by concerns that they are too highly leveraged and risk becoming insolvent.
To address this, seven banks (Abbey, Barclays, HBoS, HSBC, Lloyds TSB, RBS and Standard Chartered) and one building society (Nationwide) have agreed with the Government that they will raise their aggregate “Tier 1 capital” by £25 billion by the end of this year. The Government has agreed to provide this £25 billion of funding if required, plus at least another £25 billion if these and other financial institutions require funds from it for further capital raising.
It is expected that the relevant institutions will raise this capital by the issue of preference shares or their building society equivalent, PIBS (permanent interest bearing shares). These shares usually give the holder fixed rates of return and are repayable on a fixed maturity date (unlike ordinary shares) but, on an insolvency, they rank behind all creditors (but before ordinary shares). However, capital rules limit the conditions of preference shares, so that bank issuers retain significant flexibility as to payment of dividends and as to redemption.
The £25 billion figure applies collectively to the eight institutions. No details are provided of how much each will be required to raise, although presumably this has been discussed with the Government privately. This is not (at least at this stage) a part nationalisation of these banks. Banks are free to raise the additional capital independently, if they are able to do so; the Government is essentially underwriting the new capital raising requirement.
The Government will guarantee new short to medium term bonds issued by banks, up to a total value of around £250 billion
The Government has noted that it “will take decisive action to reopen the market for medium term funding for eligible institutions that raise appropriate amounts of Tier 1 capital”. Therefore, those financial institutions which recapitalise to the satisfaction of the Treasury (whether through funds being made available by the Treasury or otherwise) will benefit from a Government guarantee in support of any debt instruments of a maturity of up to 36 months issued by them in the international capital markets.
The Government will guarantee bonds in sterling, euro and US dollars of up to 36 months’ maturity issued by banks. This should re-open a key source of funding for banks.